Outlook for Economic

Activity and Prices

April 2018

Not to be released until 2:00 p.m.

Japan Standard Time on Saturday, April 28, 2018.

(English translation prepared by the Bank's staff based on the Japanese original)

Please contact the Bank of Japan at the address below in advance to request

permission when reproducing or copying the content of this document for

commercial purposes.

Secretariat of the Policy Board, Bank of Japan

P.O. Box 30, Nihonbashi, Tokyo 103-8660, Japan

Please credit the source when quoting, reproducing, or copying the content of this

document.

1

Outlook for Economic Activity and Prices (April 2018)

The Bank's View1 Summary

Japan's economy is likely to continue growing at a pace above its potential in fiscal 2018,

mainly against the background of highly accommodative financial conditions and the

underpinnings through government spending, with overseas economies continuing to grow

firmly. From fiscal 2019 through fiscal 2020, the economy is expected to continue on an

expanding trend supported by external demand, although the growth pace is projected to

decelerate due to a cyclical slowdown in business fixed investment and the effects of the

scheduled consumption tax hike.2

The year-on-year rate of change in the consumer price index (CPI, all items less fresh

food) has continued to show relatively weak developments when excluding the effects of

energy prices compared to the economic expansion and the labor market tightening,

mainly against the background that firms' wage- and price-setting stance has remained

cautious. Nonetheless, medium- to long-term inflation expectations are projected to rise as

firms' stance gradually shifts toward raising wages and prices with an improvement in the

output gap continuing. As a consequence, the year-on-year rate of change in the CPI is

likely to continue on an uptrend and increase toward 2 percent.

Comparing the current projections through fiscal 2019 with the previous ones, the

projected growth rates are somewhat higher and the projected rates of increase in the CPI

are more or less unchanged.

With regard to the risk balance, upside and downside risks to economic activity are

generally balanced in fiscal 2018, but risks are skewed to the downside for fiscal 2019

onward. Risks to prices are skewed to the downside. On the price front, the momentum

toward achieving the price stability target of 2 percent is maintained as the output gap is

expected to continue improving and medium- to long-term inflation expectations are

projected to rise gradually; however, the momentum is not yet sufficiently firm, and thus

developments in prices continue to warrant careful attention.

As for the conduct of monetary policy, the Bank will continue with "Quantitative and

Qualitative Monetary Easing (QQE) with Yield Curve Control," aiming to achieve the price

stability target of 2 percent, as long as it is necessary for maintaining that target in a stable

manner. It will continue expanding the monetary base until the year-on-year rate of

increase in the observed CPI (all items less fresh food) exceeds 2 percent and stays

above the target in a stable manner. The Bank will make policy adjustments as

appropriate, taking account of developments in economic activity and prices as well as

financial conditions, with a view to maintaining the momentum toward achieving the price

stability target.

1 The text of "The Bank's View" -- the outlook for economic activity and prices as well as the Bank's

thinking on the conduct of monetary policy, both of which are based on individual Policy Board members'

views -- was decided by the Policy Board at the Monetary Policy Meeting held on April 26 and 27, 2018.

2 The April 2018 Outlook for Economic Activity and Prices (Outlook Report) assumes that the

consumption tax will be raised to 10 percent in October 2019 and that a reduced tax rate will be applied to

food and beverages -- excluding alcohol and dining-out -- and newspapers. It also factors in policies

concerning the provision of free education based on information available at this point.

2

I. The Current Situation of Economic Activity and Prices in Japan

Japan's economy is expanding moderately, with a virtuous cycle from income to spending

operating. Overseas economies have continued to grow firmly on the whole. In this

situation, exports have been on an increasing trend. On the domestic demand side,

business fixed investment has continued on an increasing trend with corporate profits and

business sentiment maintaining their improving trend. Private consumption has been

increasing moderately, albeit with fluctuations, against the background of steady

improvement in the employment and income situation. Housing investment has been

weakening somewhat. Meanwhile, public investment has been more or less flat,

remaining at a relatively high level. Reflecting these increases in demand both at home

and abroad, industrial production has been on an increasing trend, and labor market

conditions have continued to tighten steadily. Financial conditions are highly

accommodative. On the price front, the year-on-year rate of change in the CPI (all items

less fresh food, and the same hereafter) is around 1 percent. Inflation expectations have

been more or less unchanged.

II. Baseline Scenario of the Outlook for Economic Activity and Prices in Japan

A. Baseline Scenario of the Outlook for Economic Activity

With regard to the outlook, Japan's economy is likely to continue its moderate expansion.

In fiscal 2018, domestic demand is likely to follow an uptrend, with a virtuous cycle from

income to spending being maintained in both the corporate and household sectors, mainly

against the background of highly accommodative financial conditions and the

underpinnings through government spending. Business fixed investment is likely to

continue increasing amid accommodative financial conditions, led mainly by investment

intended for domestic capacity expansion in line with the economic expansion, Olympic

Games-related investment, and labor-saving investment to address the labor shortage.

Private consumption is also expected to follow a moderate increasing trend as the

employment and income situation continues to improve. Public investment is expected to

remain at a relatively high level, mainly reflecting the supplementary budget for fiscal 2017

and Olympic Games-related demand, although the positive effects resulting from the

government's past stimulus measures are likely to diminish moderately. Exports are

expected to continue their moderate increasing trend on the back of the firm growth in

overseas economies. On this basis, the economy is likely to continue growing at a pace

3

above its potential in fiscal 2018.3

In fiscal 2019 and fiscal 2020, Japan's economy is expected to continue on an expanding

trend supported by external demand, although the growth pace is projected to decelerate,

reflecting a slowdown in domestic demand. Specifically, the pace of increase in private

consumption is projected to be moderate in fiscal 2019 and fiscal 2020, mainly because it

is likely to temporarily turn to a decline due to the effects of the scheduled consumption

tax hike in October 2019.4 On the other hand, exports are projected to maintain their

increasing trend on the back of the firm growth in overseas economies. Meanwhile, the

pace of increase in business fixed investment is likely to decelerate gradually through

fiscal 2020, mainly reflecting cyclical adjustments in capital stock after the prolonged

economic expansion, as well as Olympic Games-related demand peaking out; however,

the deceleration is expected to be moderate, due partly to growing demand for fixed

investment stemming from the increase in exports.

Comparing the current projections through fiscal 2019 with the previous ones, the

projected growth rates are somewhat higher, mainly reflecting the firm growth in overseas

economies.

Looking at the financial conditions on which the above outlook is based, short- and

long-term real interest rates are assumed to be in negative territory throughout the

projection period as the Bank pursues "QQE with Yield Curve Control."5 Financial

institutions' proactive lending attitudes, as well as favorable conditions for corporate

bonds and CP issuance, are both likely to be maintained and support firms' and

households' activities from the financial side. Thus, financial conditions are likely to remain

highly accommodative.

The potential growth rate is expected to follow a moderate uptrend throughout the

projection period against the backdrop of the following: progress in implementation of the

government's growth strategy, including regulatory and institutional reforms; an increase

3 Under a specific methodology, Japan's potential growth rate is estimated to be in the range of 0.5-1.0

percent. However, the estimate of the potential growth rate varies depending on the methodologies

employed and could be revised as the sample period becomes longer over time. Thus, it should be

regarded as being subject to a considerable margin of error.

4 The consumption tax hike scheduled to take place in October 2019 will affect the GDP growth rates

through the following two channels: (1) the front-loaded increase and subsequent decline in demand prior

to and after the consumption tax hike and (2) the effects of a decline in real income. Although it is subject

to considerable uncertainties, the negative impact on the growth rates is expected to be smaller than that

on the rate for fiscal 2014, when the last consumption tax hike took place. 5 Individual Policy Board members make their forecasts taking into account the effects of past policy

decisions and with reference to views incorporated in financial markets regarding future policy.

Specifically, each Policy Board member makes an assumption about the future path of short- and

long-term interest rates based on their market rates, bearing in mind the difference in the outlook for

prices between that presented in the Outlook Report and that of market participants.

4

in labor participation by women and seniors under such strategy; and firms' continued

efforts toward improving productivity. Along with this, the natural rate of interest is

projected to rise, thereby enhancing monetary easing effects.

B. Baseline Scenario of the Outlook for Prices

Although the year-on-year rate of increase in the CPI has been accelerating gradually, it

has continued to show relatively weak developments compared to the economic

expansion and the labor market tightening, remaining at around 0.5 percent excluding the

effects of energy prices.

This is attributable to the fact that the mindset and behavior based on the assumption that

wages and prices will not increase easily have been deeply entrenched among firms and

households. Firms have been making efforts to absorb a rise in labor costs by increasing

labor-saving investment and streamlining their business process, while limiting wage

increases -- which correspond to the labor shortage -- mainly to part-time employees. As

suggested by these developments, firms' wage- and price-setting stance has remained

cautious despite the steady tightening of labor market conditions and the high levels of

corporate profits. However, the upward pressure on prices stemming from the rise in firms'

costs has been increasing, partly due to a continued clear uptrend in hourly scheduled

cash earnings of part-time employees and a rise in input prices.

With regard to the outlook, the year-on-year rate of change in the CPI is likely to continue

on an uptrend and increase toward 2 percent, mainly on the back of the improvement in

the output gap and the rise in medium- to long-term inflation expectations.

Comparing the current projections through fiscal 2019 with the previous ones, the

projected rates of increase in the CPI are more or less unchanged.6

The mechanism through which the year-on-year rate of change in the CPI increases

toward 2 percent can be explained by the following factors that determine inflation rates.

First, the output gap -- which shows the utilization of labor and capital -- has widened

steadily within positive territory on the back of the steady tightening of labor market

conditions and a rise in capital utilization rates. Going forward, as the economy continues

its moderate expansion, the output gap is expected to widen further within positive

territory in fiscal 2018 and remain substantially positive in fiscal 2019 and fiscal 2020.

6 Assuming that the rise in the consumption tax will be fully passed on to prices of taxable items,

excluding those to which a reduced tax rate will be applied, the effect of the October 2019 consumption

tax hike on the year-on-year rate of change in the CPI (all items less fresh food) for October 2019 onward

is estimated to be 1.0 percentage point; the effect for fiscal 2019 and fiscal 2020 is estimated to be 0.5

percentage point for each year. It also is assumed that the effects of policies concerning the provision of

free education will not be reflected in the CPI, as statistical treatment of these effects is not yet decided.

5

Second, medium- to long-term inflation expectations have been more or less unchanged

recently, after having remained in a weakening phase since summer 2015. As for the

outlook, such expectations are likely to follow an increasing trend and gradually converge

to around 2 percent on the back of the following: (1) in terms of the adaptive component,

with the improvement in the output gap, firms' stance is likely to gradually shift toward

raising wages and prices and the observed inflation rate is expected to rise steadily, and

(2) in terms of the forward-looking component, the Bank will pursue monetary easing

through its strong commitment to achieving the price stability target.7

Regarding import prices, the past pick-up in crude oil prices has pushed up energy prices

in the CPI, but this effect is likely to wane moderately.

III. Risks to Economic Activity and Prices

A. Risks to Economic Activity

The following four factors are upside and downside risks to the Bank's baseline scenario

regarding the economy.

The first is developments in overseas economies. Specifically, the following are

considered as risks: the U.S. economic policies and their impact on global financial

markets; developments in emerging and commodity-exporting economies; negotiations

on the United Kingdom's exit from the European Union (EU) and their effects; and

geopolitical risks.

The second risk is the effects of the consumption tax hike scheduled to take place in

October 2019. It is likely that the effects of the front-loaded increase and subsequent

decline in demand prior to and after the consumption tax hike and of the decline in real

income will depend on consumer sentiment, the employment and income situation, and

developments in prices.

Third, firms' and households' medium- to long-term growth expectations may be either

raised or lowered depending on the following: efforts to address medium- to long-term

issues such as the aging population; developments in regulatory and institutional reforms,

particularly in the labor market; innovation in the corporate sector; and the employment

and income situation.

7 Medium- to long-term inflation expectations can be regarded as consisting of two components: a

forward-looking component, in which inflation expectations converge to the price stability target set by the

central bank, and a backward-looking, or adaptive, component that reflects the observed inflation rate.

For details, see the Bank's Comprehensive Assessment: Developments in Economic Activity and Prices

as well as Policy Effects since the Introduction of Quantitative and Qualitative Monetary Easing (QQE)

released in September 2016.

6

Fourth, in the event that confidence in fiscal sustainability in the medium to long term

declines, the economy may deviate downward from the baseline scenario through

increasing concerns regarding the future and the rises in long-term interest rates

associated with them. On the other hand, there is also a possibility that the economy will

deviate upward from the baseline scenario if confidence in the path toward fiscal

consolidation strengthens and concerns regarding the future are alleviated.

B. Risks to Prices

Other than risks to economic activity, the specific factors that could exert upside and

downside risks to prices are as follows. The first factor is developments in firms' and

households' medium- to long-term inflation expectations. Although inflation expectations

are likely to follow an increasing trend, there is a risk that a rise in such expectations will

lag behind if it takes time for firms' stance to shift toward raising wages and prices and

inflation consequently remains relatively sluggish.

The second factor is the fact that there are items for which prices are not particularly

responsive to the output gap. There is concern about the continued dull responses of

administered prices, some services prices, and housing rent, which may continue to

constrain the acceleration of CPI inflation. In addition, with regard to goods and services

that are difficult to differentiate, their prices may also constrain the acceleration of CPI

inflation if competition among firms intensifies further, due mainly to changes in the

distribution system and deregulation.

Third, developments in foreign exchange rates and international commodity prices going

forward, as well as the extent to which such developments will spread to import prices and

domestic prices, may lead prices to deviate either upward or downward from the baseline

scenario.

IV. Conduct of Monetary Policy

In the context of the price stability target, the Bank assesses the aforementioned

economic and price situation from two perspectives and then outlines its thinking on the

future conduct of monetary policy.8

The first perspective concerns an examination of the baseline scenario for the outlook.

The year-on-year rate of change in the CPI is likely to increase toward 2 percent. Although

it is necessary to carefully examine the fact that firms' wage- and price-setting stance has

8 As for the examination from two perspectives in the context of the price stability target, see the Bank's

statement released on January 22, 2013, entitled "The 'Price Stability Target' under the Framework for the

Conduct of Monetary Policy."

7

remained cautious, the momentum toward achieving the price stability target of 2 percent

appears to be maintained. This is because (1) firms' stance is likely to gradually shift

toward raising wages and prices with the steady improvement in the output gap, and (2)

medium- to long-term inflation expectations have been more or less unchanged recently

and such expectations are projected to rise steadily as further price rises come to be

observed widely.

The second perspective involves an examination of the risks considered most relevant to

the conduct of monetary policy. With regard to the outlook for economic activity, upside

and downside risks are generally balanced in fiscal 2018, but risks are skewed to the

downside for fiscal 2019 onward. Regarding the outlook for prices, risks are skewed to the

downside, especially concerning developments in medium- to long-term inflation

expectations. Examining financial imbalances from a longer-term perspective, there is no

sign so far of excessively bullish expectations in asset markets or in the activities of

financial institutions. Furthermore, prolonged downward pressure on financial institutions'

profits under the continued low interest rate environment could create risks of a gradual

pullback in financial intermediation and of destabilizing the financial system. However, at

this point, these risks are judged as not significant, mainly because financial institutions

have sufficient capital bases.9

As for the conduct of monetary policy, the Bank will continue with "QQE with Yield Curve

Control," aiming to achieve the price stability target of 2 percent, as long as it is necessary

for maintaining that target in a stable manner. It will continue expanding the monetary

base until the year-on-year rate of increase in the observed CPI (all items less fresh food)

exceeds 2 percent and stays above the target in a stable manner. The Bank will make

policy adjustments as appropriate, taking account of developments in economic activity

and prices as well as financial conditions, with a view to maintaining the momentum

toward achieving the price stability target.

9 For details, see the Bank's Financial System Report (April 2018).

8

(Appendix)

Forecasts of the Majority of Policy Board Members

y/y % chg.

Real GDP CPI (all items less

fresh food)

Excluding the effects

of the consumption

tax hike

Fiscal 2017 +1.8 to +1.9

[+1.9] +0.7

Forecasts made in January 2018 +1.8 to +2.0

[+1.9]

+0.7 to +1.0

[+0.8]

Fiscal 2018 +1.4 to +1.7

[+1.6]

+1.2 to +1.3

[+1.3]

Forecasts made in January 2018 +1.3 to +1.5

[+1.4]

+1.3 to +1.6

[+1.4]

Fiscal 2019 +0.7 to +0.9

[+0.8]

+2.0 to +2.3

[+2.3]

+1.5 to +1.8

[+1.8]

Forecasts made in January 2018 +0.7 to +0.9

[+0.7]

+2.0 to +2.5

[+2.3]

+1.5 to +2.0

[+1.8]

Fiscal 2020 +0.6 to +1.0

[+0.8]

+2.0 to +2.3

[+2.3]

+1.5 to +1.8

[+1.8]

Notes: 1. Figures in brackets indicate the medians of the Policy Board members' forecasts (point estimates).

2. The forecasts of the majority of the Policy Board members are constructed as follows: each Policy Board

member's forecast takes the form of a point estimate -- namely, the figure to which he or she attaches the highest

probability of realization. These forecasts are then shown as a range, with the highest figure and the lowest

figure excluded. The range does not indicate the forecast errors.

3. Individual Policy Board members make their forecasts taking into account the effects of past policy decisions and

with reference to views incorporated in financial markets regarding future policy. Specifically, each Policy Board

member makes an assumption about the future path of short- and long-term interest rates based on their market

rates, bearing in mind the difference in the outlook for prices between that presented in the Outlook Report and

that of market participants.

4. The consumption tax hike scheduled to take place in October 2019 -- to 10 percent -- and the reduced tax rate to

be applied to food and beverages -- excluding alcohol and dining-out -- and newspapers are incorporated in the

forecasts, but individual Policy Board members make their forecasts of the CPI based on figures excluding the

direct effects of the consumption tax hike. The forecasts for the CPI for fiscal 2019 and fiscal 2020 that

incorporate the direct effects of the consumption tax hike are constructed as follows. First, the contribution to

prices from the tax hike is mechanically computed on the assumption that the tax increase will be fully passed on

for taxable items. The CPI will be pushed up by 0.5 percentage point for each year. Second, this figure is added

to the forecasts made by the Policy Board members. While it is assumed that the effects of policies concerning

the provision of free education will not be reflected in the CPI as statistical treatment of these effects is not yet

decided, the effects of such policies are factored in by individual Policy Board members for their forecasts of the

real GDP growth rates, based on information available at this point.

5. The CPI (all items less fresh food) for fiscal 2017 is an actual figure.

9

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

y/y % chg. y/y % chg.

FY

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

y/y % chg. y/y % chg.

FY

Policy Board Members' Forecasts and Risk Assessments

(1) Real GDP

(2) CPI (All Items Less Fresh Food)

Notes: 1. Solid lines show actual figures, while dotted lines show the medians of the Policy Board members'

forecasts (point estimates).

2. The locations of , △, and ▼ in the charts indicate the figures for each Policy Board member's forecasts

to which he or she attaches the highest probability. The risk balance assessed by each Policy Board

member is shown by the following shapes: indicates that a member assesses "upside and downside

risks as being generally balanced," △ indicates that a member assesses "risks are skewed to the

upside," and ▼ indicates that a member assesses "risks are skewed to the downside."

3. Figures for the CPI exclude the direct effects of the consumption tax hikes.

10

The Background10

I. The Current Situation of Economic

Activity and Its Outlook

A. Economic Developments

Looking back at Japan's economy since the

January 2018 Outlook Report, the real GDP

growth rate for the October-December quarter of

2017 was 0.4 percent on a quarter-on-quarter

basis and its annualized rate was 1.6 percent,

representing positive growth for eight consecutive

quarters (Chart 1). While net exports were more

or less flat, mainly because imports increased

amid exports maintaining their pace of increase,

with regard to domestic private demand, private

consumption and business fixed investment

increased firmly. Thus, the real GDP growth rate

as a whole was above the potential growth rate,

which is estimated to be in the range of 0.5-1.0

percent (Chart 2). Reflecting these increases in

demand, labor market conditions have continued

to tighten steadily (Chart 3). The output gap --

which captures the utilization of labor and capital

-- has improved steadily of late and was around

1.5 percent for the October-December quarter

(Chart 4). Monthly indicators since January

suggest that the uptrend in the output gap is likely

to continue. Therefore, Japan's economy has

continued to expand moderately, with a virtuous

cycle from income to spending operating.

With regard to the outlook, Japan's economy is

likely to continue growing at a pace clearly above

its potential through fiscal 2018, mainly against

10 "The Background" provides explanations of "The Bank's View"

decided by the Policy Board of the Bank of Japan at the Monetary

Policy Meeting held on April 26 and 27, 2018.

-15

-10

-5

0

5

10

15

1 0 1 1 1 2 1 3 1 4 1 5 1 6 1 7

Private demand

Public demand

Net exports

Real GDP

s.a., ann., q/q % chg.

Chart 1: Real GDP

Source: Cabinet Office.

CY

-2

-1

0

1

2

3

4

5

85 90 95 00 05 10 15

Total factor productivity

Capital input

Labor input

Potential growth rate

Chart 2: Potential Growth Ratey/y % chg.

FYSource: Bank of Japan.Note: Based on staff estimations. Figures for the second half of fiscal 2017 are those for

2017/Q4.

11

the background of highly accommodative financial

conditions and the underpinnings through

government spending, with overseas economies

continuing to grow firmly. From fiscal 2019

through fiscal 2020, the economy is expected to

continue on an expanding trend supported by

external demand, although the growth rate is

projected to decelerate from fiscal 2018. This is

likely to be attributable to (1) the deceleration in

business fixed investment reflecting cyclical

adjustments in capital stock as well as Olympic

Games-related investment peaking out, combined

with (2) a temporary decline in private

consumption due to the scheduled consumption

tax hike.11,12

Comparing the current projections

through fiscal 2019 with those presented in the

previous Outlook Report, the projected growth

rates are somewhat higher, as the increase in

11 The April 2018 Outlook Report assumes that the consumption

tax will be raised to 10 percent in October 2019 and that a reduced

tax rate will be applied to food and beverages -- excluding alcohol

and dining-out -- and newspapers.

12 The scheduled consumption tax hike in October 2019 will have

some impact on the GDP growth rates, mainly due to changes in

household spending, through the following two channels: (1) the

front-loaded increase and subsequent decline in demand prior to

and after the consumption tax hike and (2) the effects of the

decline in real income. At present, the negative impact of the tax

hike on the growth rates for fiscal 2019 and fiscal 2020 is expected

to be smaller than that on the rate for fiscal 2014, when the last

consumption tax hike took place. This is mainly due to the

following: (1) there are technical factors that, as the consumption

tax hike is scheduled to take place in the middle of fiscal 2019, the

front-loaded increase and subsequent decline in demand prior to

and after the hike will offset each other during that fiscal year --

although they will push down the growth rate for fiscal 2020 -- and

that the effects of the decline in real income will be dispersed over

fiscal 2019 and fiscal 2020; (2) the increase in the consumption

tax rate is smaller than that of the previous tax hike and a reduced

tax rate will be applied to some items; (3) the provision of free

education as well as various measures to reduce the household

burden of the tax hike will be implemented; and (4) before the

previous tax hike, there likely was a front-loaded increase in

demand in anticipation of the second round of the tax hike. For the

increase in the net burden on households around the time of

consumption tax hikes, see Box 1. It should be noted, however,

that the impact of the consumption tax hike is uncertain and varies

depending, for example, on developments in consumer sentiment.

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2

3

4

5

6

7

03 05 07 09 11 13 15 17

Unemployment rate (left scale)

Structural unemployment rate (left scale)

Active job openings-to-applicants ratio(right scale)

Chart 3: Labor Market Conditionss.a., %

CYSources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and

Welfare.Note: The structural unemployment rate is based on staff estimations.

s.a., ratio

12

exports and its spillover effects are expected be

larger than in the previous projections, based on

the outlook that overseas economies will continue

to grow more firmly.

Details of the outlook for each fiscal year are as

follows. In fiscal 2018, the economy is likely to

maintain a moderate expansion with demand at

home and abroad increasing in a well-balanced

manner. Specifically, exports are projected to

continue increasing moderately, reflecting the firm

growth in overseas economies. Business fixed

investment is also expected to continue to see a

steady increase amid accommodative financial

conditions, led mainly by investment intended for

domestic capacity expansion in line with the

economic expansion, Olympic Games-related

investment, and labor-saving investment

stemming from the labor shortage. Private

consumption will likely maintain its momentum,

supported by the rise in disposable income

resulting from increases in base pay rises.

Meanwhile, public investment is projected to

remain at a high level, mainly underpinned by the

supplementary budget for fiscal 2017 and

Olympic Games-related demand, although the

positive effects resulting from the past stimulus

measures will diminish moderately. On this basis,

the real GDP growth rate for fiscal 2018 is

projected to exceed the potential and the output

gap is likely to continue improving.

In fiscal 2019, the growth pace is projected to

decelerate, mainly due to a slowdown in domestic

demand. Private consumption is expected to

increase its momentum in the first half of the fiscal

year, reflecting the front-loaded increase in

-40

-30

-20

-10

0

10

20

30

40-8

-6

-4

-2

0

2

4

6

8

85 90 95 00 05 10 15

Output gap (left scale)

Tankan factor utilizationindex (right scale)

% reversed, DI ("excessive" - "insufficient"), % points

Chart 4: Output Gap

Source: Bank of Japan.Notes: 1. The output gap is based on staff estimations.

2. The Tankan factor utilization index is calculated as the weighted average of theproduction capacity DI and the employment conditions DI for all enterprises.The capital and labor shares are used as weights. There is a discontinuity in the data in December 2003 due to a change in the survey framework.

3. Shaded areas indicate recession periods.

CY

13

demand prior to the scheduled consumption tax

hike, and then start declining in the second half of

the fiscal year, pushed down by the subsequent

decline in demand following the tax hike and the

effects of the decline in real income. However,

exports are projected to maintain their increasing

trend on the back of the firm growth in overseas

economies, and thereby underpin the economy.

Meanwhile, business fixed investment is likely to

decelerate gradually under cyclical downward

pressure resulting from capital stock adjustments,

combined with the effects of Olympic

Games-related investment peaking out; however,

the deceleration is expected to be moderate, due

partly to growing demand for fixed investment

stemming from the increase in exports. As a result

of these developments, the economy is expected

to continue on an expanding trend, although the

growth rate for fiscal 2019 is projected to

decelerate from the previous fiscal year.

In fiscal 2020, private consumption and housing

investment are expected to gradually head toward

a recovery after declining in the second half of

fiscal 2019. Exports are likely to continue their

increasing trend. On the other hand, business

fixed investment will likely decelerate somewhat

as pressure to adjust accumulated capital stock

heightens, although the increase in exports is

likely to continue stimulating investment demand.

Meanwhile, expenditure accompanying the

hosting of the Olympic Games, such as on

temporary facilities, is expected to underpin the

economy. Under such circumstances, the

economy is expected to continue on an

expanding trend in fiscal 2020.

14

The potential growth rate is expected to follow a

moderate uptrend throughout the projection

period against the backdrop of the following:

progress in implementation of the government's

growth strategy, including regulatory and

institutional reforms; an increase in labor

participation by women and seniors under such

strategy; and firms' continued efforts toward

improving productivity.

15

B. Developments in Major Expenditure

Items and Their Background

Government Spending

Public investment has been more or less flat,

remaining at a relatively high level (Chart 5). As

for the outlook, it is expected to decline as the

positive effects resulting from the government's

large-scale stimulus measures formulated in fiscal

2016 diminish, but remain at a relatively high level,

mainly underpinned by the supplementary budget

for fiscal 2017 and Olympic Games-related

construction.13

Overseas Economies

Overseas economies have continued to grow

firmly on the whole (Chart 6). The business

sentiment of manufacturing firms on a global

basis has maintained its improving trend,

although it recently has declined somewhat, and

the world trade volume has continued to recover

(Charts 7 and 12). Looking at developments by

major region, the U.S. economy has been

expanding and the European economy has

continued to recover firmly. The Chinese

economy has continued to see stable growth on

the whole. Other emerging economies and

commodity-exporting economies have been

recovering moderately on the whole, reflecting in

particular an increase in exports and the effects of

13 The supplementary budget for fiscal 2017 and the initial budget

for fiscal 2018 were approved by the Diet. With regard to the

budget related to public investment, 1.3 trillion yen was included in

the supplementary budget for fiscal 2017 (2.0 trillion yen was

included in the second supplementary budget for fiscal 2016),

mainly for the purpose of funding the projects for disaster relief,

disaster prevention, and disaster reduction, which are likely to be

implemented mainly in fiscal 2018. In the initial budget for fiscal

2018, 6.0 trillion yen was included for the budget related to public

works, which is about the same level as in the initial budget for

fiscal 2017.

22

23

24

25

26

27

28

29

30

31

32

15

16

17

18

19

20

21

22

23

24

25

08 09 10 11 12 13 14 15 16 17 18

Public construction completed (nominal, left scale)

Public investment (real, right scale)

Chart 5: Public Investments.a., ann., tril. yen s.a., ann., tril. yen

Sources: Cabinet Office; Ministry of Land, Infrastructure, Transport and Tourism.Note: The figure for 2018/Q1 is the January-February average.

CY

-6

-4

-2

0

2

4

6

8

10

85 90 95 00 05 10 15 20

Overseas total

Advanced economies

Emerging and commodity-exporting economies

Chart 6: Overseas Economiesy/y % chg.

CY

IMFprojection

Sources: IMF; Ministry of Finance.Note: Figures are the weighted averages of real GDP growth rates using countries' share in

Japan's exports as weights. Annual GDP growth rates are from the "World Economic Outlook (WEO)" as of April 2018. Advanced economies consist of the United States, the euro area, and the United Kingdom. Emerging and commodity-exporting economies consist of the rest of the world economy.

47

50

53

56

59

10 11 12 13 14 15 16 17 18

Global economy

Advanced economies

Emerging and commodity-exportingeconomies

Chart 7: Global Manufacturing PMIs.a., DI

Sources: IHS Markit (© and database right IHS Markit Ltd 2018. All rights reserved.), etc.Note: Figures for the global economy are the "J.P. Morgan Global Manufacturing PMI."

Figures for advanced economies as well as emerging and commodity-exporting economies are calculated as the weighted averages of the Manufacturing PMI using GDP shares of world total GDP from the IMF as weights. Advanced economies consist of the United States, the euro area, the United Kingdom, and Japan. Emerging and commodity-exporting economies consist of 17 countries and regions, such as China, South Korea, Taiwan, Russia, and Brazil.

CY

16

those economies' stimulus measures.

In terms of the outlook, overseas economies are

expected to continue growing firmly as global

production and trade activity of the manufacturing

sector are likely to be firm, and both the advanced

and emerging economies are projected to grow in

a well-balanced manner.

By major region, the U.S. economy is expected to

keep expanding. The European economy is

projected to continue recovering. The Chinese

economy is likely to broadly follow a stable growth

path as authorities conduct fiscal and monetary

policy in a timely manner. Other emerging

economies and commodity-exporting economies

are likely to continue their moderate recovery on

the whole.

20

40

60

80

100

120

140

160

80 85 90 95 00 05 10 15

Real effective exchange rate

Nominal effective exchange rate

Sources: BIS; Bank of Japan.Notes: 1. Figures are based on the broad index of the "BIS Effective Exchange Rate."

Those prior to 1994 are calculated using the narrow index.2. Figures for April 2018 have been calculated using the daily nominal effective

exchange rate (the Yen Index) compiled by the Bank of Japan.

Chart 8: Effective Exchange RatesCY 2010=100

Yenappreciation

Yendepreciation

CY

17

Exports and Imports

Exports have been on an increasing trend on the

back of the firm growth in overseas economies

(Chart 9). By region, exports to advanced

economies have continued on their increasing

trend when fluctuations are smoothed out.

Exports to emerging economies have been

picking up broadly, such as those of capital goods

and intermediate goods -- including chemicals as

well as iron and steel -- to Asia (Chart 10). By

goods, automobile-related exports have

continued to increase, due in part to the rising

value-added of automobiles exported from Japan

(Chart 11). IT-related exports have decreased

recently, affected by production adjustments for

smartphones, although electronic parts for data

centers and motor vehicles have continued to see

firm demand. Exports of a wide range of capital

goods have been on an increasing trend, mainly

led by semiconductor production equipment,

industrial robots, as well as parts including

bearings and metal valves.

Exports will likely continue their increasing trend

for the time being, as those of capital goods and

IT-related goods -- in which Japan has a

comparative advantage -- are likely to be firm with

global production and trade activity of the

manufacturing sector remaining at a favorable

level. Thereafter, Japan's exports are expected to

continue their moderate increasing trend as (1)

the world trade volume is likely to continue its

moderate increase with the growth in overseas

economies and (2) Japan's share of exports is

expected to follow a very moderate increasing

trend, reflecting improvement in Japan's export

-6

-4

-2

0

2

4

6

8

10

40

50

60

70

80

90

100

110

120

03 05 07 09 11 13 15 17

Real trade balance (right scale)

Real exports (left scale)

Real imports (left scale)

Chart 9: Real Exports and Real Importss.a., CY 2015=100

CYSources: Bank of Japan; Ministry of Finance; Cabinet Office.Note: Based on staff calculations.

s.a., % of real GDP

80

90

100

110

120

130

140

150

13 14 15 16 17 18

United States <19.3>

EU <11.1>

Chart 10: Real Exports by Regions.a., 2013/Q1=100

CY

Sources: Bank of Japan; Ministry of Finance.Note: Based on staff calculations. Figures in angular brackets show the share of each

country or region in Japan's total exports in 2017.

80

90

100

110

120

130

140

150

13 14 15 16 17 18

China <19.0>

NIEs, ASEAN, etc.<35.8>

Other economies<14.8>

s.a., 2013/Q1=100

90

95

100

105

110

115

120

125

13 14 15 16 17 18

IT-related goods<21.3>

Capital goods <17.5>

s.a., 2013/Q1=100

90

95

100

105

110

115

120

125

13 14 15 16 17 18

Intermediate goods<19.1>

Motor vehicles andrelated goods <24.0>

Sources: Bank of Japan; Ministry of Finance.Note: Based on staff calculations. Figures in angular brackets show the share of each

type of goods in Japan's total exports in 2017.

Chart 11: Real Exports by Type of Goodss.a., 2013/Q1=100

CY

18

competitiveness (Charts 12 and 13).14,15

Looking at this in detail, the world trade volume

has accelerated its growth pace recently, mainly

for Asia as well as the United States and Europe.

Going forward, the pace of increase in the world

trade volume is expected to be about the same as

that in world economic growth, albeit with

fluctuations -- that is, the world trade volume to

GDP ratio is likely to be more or less unchanged

-- as a global recovery in production and trade

activity of the manufacturing sector is likely to

continue.

Japan's share of exports in world trade has been

on a rising trend, due in part to an increase in

demand for capital goods and IT-related goods, in

which Japan has a comparative advantage. It is

expected to follow a very moderate rising trend,

as an uptrend in exports of capital goods is likely

to continue, supported by the recovery in demand

for business fixed investment on a global basis.

Imports have been picking up (Chart 9). Going

forward, they are expected to follow a moderate

uptrend, reflecting an increase in domestic

demand; however, the pace is projected to remain

only moderate due to a downtrend in imports of

raw materials, reflecting an improvement in

energy efficiency.

14 The world trade volume is calculated by adding up real imports

in each country.

15 Box 2 shows the results of analysis suggesting that the

structure of Japan's real exports has changed in recent years,

becoming less affected by exchange rates.

-20

-15

-10

-5

0

5

10

15

20

03 05 07 09 11 13 15 17

Trade volume

Real GDP

Chart 12: World Trade Volume and Real GDP of the World Economy

y/y % chg.

Sources: CPB Netherlands Bureau for Economic Policy Analysis; IMF, etc.Notes: 1. Figures for the trade volume are those for real imports.

The figure for 2018/Q1 is the January-February average.2. Real GDP of the world economy is based on staff calculations using GDP shares

of world total GDP from the IMF as weights.

CY

4.0

4.2

4.4

4.6

4.8

5.0

5.2

5.4

5.6

5.8

03 05 07 09 11 13 15 17

Chart 13: Japan's Share of Exports in World Trade

s.a., %

Source: CPB Netherlands Bureau for Economic Policy Analysis.Note: Japan's share of exports in world trade is obtained by dividing Japan's real exports by

world real imports (2010 prices). The figure for 2018/Q1 is the January-February average.

CY

19

External Balance

The nominal current account surplus has been on

an increasing trend, mainly backed by the primary

income balance and the trade balance (Chart 14).

Going forward, the nominal current account

surplus will likely increase moderately, mainly on

the back of (1) an improving trend in the trade

balance that reflects the aforementioned outlook

for exports and imports, as well as (2) an

improvement in the primary income balance

brought about by the growth in overseas

economies and (3) an increase in travel receipts

underpinned by a rise in the number of inbound

visitors.16

In terms of the saving-investment balance, the

increase in the nominal current account surplus

corresponds to that in excess saving as a whole.

By sector, although excess saving in the

household sector is expected to decline very

moderately due to a rise in the propensity to

consume, it is projected to be more or less flat

thereafter, partly reflecting the effects of the

scheduled consumption tax hike. Excess saving

in the corporate sector is likely to decrease very

moderately, although remain at a high level, as an

improvement in profits is expected to contribute to

an increase in fixed investment with some time

lag.17

Meanwhile, excess investment in the

general government is projected to decrease,

16 An appreciation of the yen exerts downward pressure on

corporate profits when dividend payments from abroad are

converted into yen and also affects the income balance. Box 2

outlines this point.

17 With regard to the background to the increase in corporate

savings and the impact on business fixed investment, see Box 3 in

the January 2018 Outlook Report.

-30

-20

-10

0

10

20

30

08 09 10 11 12 13 14 15 16 17 18

Trade balance

Services balance

Primary income balance

Secondary income balance

Current account

s.a., ann., tril. yen

Chart 14: Current Account

Source: Ministry of Finance and Bank of Japan.Note: Figures for 2018/Q1 are January-February averages.

CY

20

reflecting a dissipation of the effects resulting

from the past stimulus measures and the

scheduled consumption tax hike.

21

Industrial Production

Industrial production has been on an increasing

trend on the back of the increase in demand at

home and abroad (Chart 15). Transport

equipment production has turned to a decline with

replacement demand for automobiles after the

hurricanes in the United States peaking out,

coupled with the effects of production disruption

caused by heavy snowfall in Japan. Excluding

such temporary effects, however, transport

equipment production appears to be maintaining

its increasing trend, mainly against the

background of a shift of production sites from

overseas back to Japan. The production of

electronic parts and devices has remained on an

increasing trend on the back of the continued

robust demand for parts for data centers and

on-board equipment for motor vehicles, although

demand for parts for smartphones has been

decreasing recently. The production of machinery

(i.e., "general-purpose, production and business

oriented machinery" in the Indices of Industrial

Production) has been on a moderate increasing

trend, mainly driven by semiconductor production

equipment and industrial robots. The production

of chemicals has been increasing on average,

mainly led by cosmetics, albeit with large

fluctuations. Meanwhile, with regard to the

shipments-inventories balance, the year-on-year

rate of change in shipments and that in

inventories have been more or less the same

(Chart 16).

Industrial production will likely continue to

increase firmly for the time being on the back of

the increase in demand at home and abroad.

Thereafter, it is projected to continue on a

moderate increasing trend with the growth in

70

80

90

100

110

120

130

03 05 07 09 11 13 15 17

Production

Shipments

Inventories

Chart 15: Production, Shipments, and Inventories

s.a., CY 2010=100

CYSource: Ministry of Economy, Trade and Industry (METI).Notes: 1. Shaded areas indicate recession periods.

2. The production figure for 2018/Q2 is calculated based on METI projections for April and May 2018.

-40

-30

-20

-10

0

10

20

30

40

-40

-30

-20

-10

0

10

20

30

40

03 05 07 09 11 13 15 17

Shipments - Inventories(right scale)

Production (left scale)

Chart 16: Shipments-Inventories Balancey/y % chg. % points

CY

Source: Ministry of Economy, Trade and Industry.

22

overseas economies.

Corporate Profits

Corporate profits have maintained their improving

trend. According to the Financial Statements

Statistics of Corporations by Industry, Quarterly

(FSSC), the ratio of current profits to sales for all

industries and enterprises has been on an

improving trend, supported by firm domestic

demand and the growth in overseas economies

(Chart 17). Under such circumstances, business

sentiment also has maintained its improving trend

(Chart 18). The diffusion index (DI) for business

conditions for all industries and enterprises in the

March 2018 Tankan (Short-Term Economic

Survey of Enterprises in Japan) suggests that

business conditions have improved for seven

consecutive quarters, being at a favorable level

last seen in the August 1991 survey.

Corporate profits are projected to continue

improving steadily, on the back of the increase in

demand at home and abroad. Nevertheless,

through fiscal 2020, the rate of increase in

corporate profits is likely to decelerate as the

allocation to households increases further, such

as in the form of a rise in personnel expenses,

with Japan's economy shifting toward a

decelerating trend due in part to the effects of the

scheduled consumption tax hike.

Business Fixed Investment

Business fixed investment has continued on an

increasing trend with corporate profits and

business sentiment maintaining their improving

0

1

2

3

4

5

6

7

03 05 07 09 11 13 15 17

Ratio of current profits to sales

Ratio of operating profits to sales

Chart 17: Corporate Profitss.a., %

CYSource: Ministry of Finance.Notes: 1. Based on the "Financial Statements Statistics of Corporations by Industry,

Quarterly." Excluding "finance and insurance."2. Shaded areas indicate recession periods.

-60

-40

-20

0

20

40

60

90 95 00 05 10 15

All Industries

Manufacturing

Nonmanufacturing

Chart 18: Business ConditionsDI ("favorable" - "unfavorable"), % points

"Favorable"

"Unfavorable"

CYSource: Bank of Japan.Notes: 1. Based on the Tankan. There is a discontinuity in the data in December 2003 due

to a change in the survey framework.2. Shaded areas indicate recession periods.

23

trend (Chart 19). The aggregate supply of capital

goods and private construction completed

(nonresidential) -- coincident indicators of

machinery investment and construction

investment, respectively -- have been increasing,

albeit with fluctuations. According to the March

Tankan, business fixed investment plans for fiscal

2017, especially those of large enterprises, are

expected to see solid results; the plans for fiscal

2018, which were surveyed for the first time in the

March Tankan, have turned out to be relatively

high compared to the past as well. For example,

business investment (on the basis close to GDP

definition; business investment -- including

software as well as research and development

investment, but excluding land purchasing

expenses -- in all industries including the financial

industry) increased by 4.3 percent in fiscal 2017,

and such investment plans for fiscal 2018 saw an

increase of 2.0 percent (Chart 20). Reflecting

firms' positive fixed investment stance, machinery

orders and construction starts (in terms of

planned expenses for private and nondwelling

construction), as leading indicators, have

continued on an increasing trend, albeit with large

monthly fluctuations (Chart 21).

With regard to the outlook, business fixed

investment is likely to continue increasing on the

back of (1) an improvement in corporate profits,

(2) extremely stimulative financial conditions,

such as low interest rates and accommodative

lending attitudes, (3) the materialization of the

effects of projects conducted under the Fiscal

Investment and Loan Program as well as the

effects of investment-enhancing tax incentives,

and (4) moderate improvement in growth

expectations. Specifically, an increase is likely to

70

80

90

100

110

120

130

140

150

160

170

60

65

70

75

80

85

90

95

03 05 07 09 11 13 15 17

Private nonresidential investment(SNA, real, left scale)

Domestic shipments and imports ofcapital goods (right scale)

Private construction completed(nonresidential, real, right scale)

Chart 19: Coincident Indicators ofBusiness Fixed Investment

s.a., ann., tril. yen s.a., CY 2010=100

CYSources: Cabinet Office; Ministry of Economy, Trade and Industry; Ministry of Land,

Infrastructure, Transport and Tourism.Notes: 1. Figures for 2018/Q1 are January-February averages.

2. Real private construction completed is based on staff calculations using price indices in the "Construction Cost Deflators."

-2

0

2

4

6

8

10

Mar. June Sept. Dec. Forecast Actual

FY 2015 FY 2016 FY 2017

Source: Bank of Japan. Notes: 1. Based on the Tankan. All Industries including financial institutions.

2. Including software and R&D investment and excluding land purchasing expenses (R&D investment is not included until the December 2016 survey).

3. There is a discontinuity in the data in December 2017 due to a change in thesurvey sample.

Chart 20: Developments in Business FixedInvestment Plans

y/y % chg. average (FY 2004-2016)

FY 2018

5

6

7

8

9

10

11

12

13

03 05 07 09 11 13 15 17

Machinery orders (private sector,excluding volatile orders)

Construction starts (private,nondwelling use, estimatedconstruction costs)

Chart 21: Leading Indicators of BusinessFixed Investment

s.a., ann., tril. yen

CYSources: Cabinet Office; Ministry of Land, Infrastructure, Transport and Tourism.Notes: 1. Volatile orders: orders for ships and orders from electric power companies.

2. Figures for 2018/Q1 are January-February averages.

24

be seen in investment such as (1) that intended

for domestic capacity expansion in line with the

economic expansion, (2) that related to the

Olympic Games and urban redevelopment

projects, (3) that aiming at improving efficiency

and saving labor in order to deal with the labor

shortage, and (4) in research and development

for growth areas.

The nominal investment-GDP ratio is expected to

continue rising further on the basis of the

aforementioned outlook for business fixed

investment (Chart 23). The ratio has reached a

level close to the peaks observed in the

investment cycles after the burst of the bubble.

Taking this into account, the pace of increase in

business fixed investment is likely to decelerate

gradually through the end of the projection period,

as pressure to adjust accumulated capital stock

heightens.

The Employment and Income Situation

Supply-demand conditions in the labor market

have continued to tighten steadily and employee

income has increased moderately. The

year-on-year rate of change in the Labour Force

Survey-based number of employees has

remained positive, at around 2 percent (Chart 24).

Against this backdrop, the active job

openings-to-applicants ratio has risen steadily,

and a perception of labor shortage suggested by

the employment conditions DI in the March

Tankan has heightened (Chart 3). The

unemployment rate has been around 2.5 percent

recently, which is slightly below the structural

03

04

05

14

07

08

09

10

11

12

13

0615

16

FY 2017

-15

-10

-5

0

5

10

10.0 10.5 11.0 11.5 12.0 12.5 13.0

Source: Cabinet Office.

Note: Each broken line represents the combination of the rate of change in fixed investment

and the investment-capital stock ratio at a certain expected growth rate.The figure for fiscal 2017 is the 2017/Q2-Q4 average.

Chart 22: Capital Stock Cycles

investment-capital stock ratio at the end of the previous fiscal year, %

fixed investment, y/y % chg.

Investment-capital stock ratio at the end of FY 2016

1%

0.5%

Expectedgrowth rate: -2% -1%

0%

1.5%

13

14

15

16

17

94 96 98 00 02 04 06 08 10 12 14 16

Investment-GDP ratio (nominal)

Average of investment-GDP ratiofrom 1994

Source: Cabinet Office.Note: Shaded areas indicate recession periods.

Chart 23: Investment-GDP Ratio (Nominal)s.a., %

CY

-8

-6

-4

-2

0

2

4

08 09 10 11 12 13 14 15 16 17

Total cash earnings

Number of employees

Employee income

Real employee income

Chart 24: Employee Incomey/y % chg.

Sources: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications.

Notes: 1. Q1 = March-May, Q2 = June-August, Q3 = September-November,Q4 = December-February.

2. Employee income = total cash earnings ("Monthly Labour Survey") × number of

employees ("Labour Force Survey")3. Real employee income is based on staff calculations using the CPI (less imputed

rent).

25

unemployment rate.18

These indicators of

supply-demand conditions in the labor market

show that the degree of labor market tightness

has been at around the level last seen in the first

half of the 1990s or in the first half of the 1970s.

Meanwhile, labor force participation rates --

especially those for women and seniors -- have

remained on an uptrend after bottoming out

around the end of 2012 (Chart 25).19

As Japan's

economy is likely to continue on a growing trend

at a pace above its potential, it is expected that

the number of employees will keep increasing and

that the supply-demand conditions in the labor

market will continue to tighten steadily.

On the wage side, total cash earnings per

employee have risen moderately, albeit with some

fluctuations (Chart 26).20

Specifically, scheduled

cash earnings as a whole have continued to

increase moderately, due in part to dissipation of

downward pressure stemming from an increase in

the ratio of part-time employees amid a rise in

wages of both full-time and part-time employees

(Chart 27). The year-on-year rate of increase in

18 The structural unemployment rate can be described in a variety

of ways, but in Chart 3, it is defined, based on the idea of the

so-called Beveridge Curve, as one where the unemployment rate

and the vacancy rate are equal to each other (i.e., when the

aggregate supply-demand conditions in the labor market --

excluding unemployment arising from the mismatch between job

openings and job applicants -- are judged as being in equilibrium).

Therefore, the structural unemployment rate defined here differs

from the concept of the Non-Accelerating Inflation Rate of

Unemployment (NAIRU), and does not show a direct relationship

with prices or wages.

19 With regard to labor force participation of women and seniors,

see Box 2 in the October 2017 Outlook Report.

20 In the Monthly Labour Survey, from the January 2018 final

report, half of the samples for establishments with 30 or more

employees were replaced, and the number of regular employees

was retroactively revised reflecting data from the 2014 Economic

Census. Thus, the weights of establishments with 5 to 29

employees and those with 30 or more employees, as well as the

ratio of part-time employees have been changed.

-6

-4

-2

0

2

08 09 10 11 12 13 14 15 16 17

Special cash earnings(bonuses, etc.)

Non-scheduled cash earnings

Scheduled cash earnings

Total cash earnings

Chart 26: Nominal Wagesy/y % chg.

Source: Ministry of Health, Labour and Welfare.Note: Q1 = March-May, Q2 = June-August, Q3 = September-November,

Q4 = December-February.

-2

-1

0

1

2

08 09 10 11 12 13 14 15 16 17

Contribution of the share of part-time employees, etc.

Contribution of part-time employees

Contribution of full-time employees

Scheduled cash earnings

Chart 27: Scheduled Cash Earningsy/y % chg.

Source: Ministry of Health, Labour and Welfare.Note: Q1 = March-May, Q2 = June-August, Q3 = September-November,

Q4 = December-February.

58

59

60

61

62

03 05 07 09 11 13 15 17

Chart 25: Labor Force Participation Rates.a., %

Source: Ministry of Internal Affairs and Communications.

CY

26

hourly scheduled cash earnings of part-time

employees, which are responsive to labor market

conditions, recently registered relatively high

growth of around 2.5 percent (Chart 28).

Meanwhile, the year-on-year rate of change in

real wages per employee has been slightly

negative, affected by a rise in prices of fresh food

and energy.

With regard to the outlook for wages, the pace of

increase in scheduled cash earnings of full-time

employees is expected to accelerate moderately

as that in base pay accelerates with the inflation

rate in the previous fiscal year rising and an

improvement in labor productivity becoming more

evident.21

The rate of increase in hourly

scheduled cash earnings of part-time employees

is also likely to accelerate steadily in response to

further tightening of labor market conditions and

an increase in minimum wages. Under this

situation, overall employees' hourly cash earnings

are projected to increase moderately at almost

the same pace as labor productivity growth in

nominal terms, and their rate of increase is

expected to accelerate in the second half of the

projection period.22

In light of the aforementioned employment and

wage conditions, employee income has been on a

21 With regard to the base pay increase for fiscal 2018, the rate of

increase in wages was 0.53 percent according to the fourth

aggregate results compiled by the Japanese Trade Union

Confederation (Rengo), which is higher than the actual rate for

fiscal 2017 (0.48 percent), but it has not reached the rate for fiscal

2015 (0.69 percent).

22 The tax reform in fiscal 2018 incorporates the enhanced tax

system for promoting income expansion in which a certain share

of the wage increases will be deducted from the corporate tax for

firms that meet certain conditions.

-4

-2

0

2

4

08 09 10 11 12 13 14 15 16 17

Hourly cash earnings

Hourly scheduled cash earnings(part-time employees)

Chart 28: Hourly Cash Earningsy/y % chg.

Source: Ministry of Health, Labour and Welfare.Note: Q1 = March-May, Q2 = June-August, Q3 = September-November,

Q4 = December-February.

27

moderate increasing trend (Chart 24). Going

forward, it is likely to increase at a moderate pace,

and the pace is expected to be slightly above the

nominal GDP growth rate in the second half of the

projection period. The labor share is likely to rise

moderately, after remaining more or less

unchanged at a level clearly below the long-term

average (Chart 29).23

Household Spending

Private consumption has been increasing

moderately, albeit with fluctuations, against the

background of steady improvement in the

employment and income situation. From the

viewpoint of gauging consumption activity in a

comprehensive manner, the Consumption Activity

Index (CAI, travel balance adjusted) -- which is

calculated by combining various sales and

supply-side statistics -- has increased, albeit with

fluctuations mainly stemming from weather

conditions (Chart 30).24

Looking at private

consumption by type, durable goods have been

on a moderate uptrend, mainly due to

replacement demand for automobiles and

household electrical appliances, although such

goods recently have decreased somewhat,

mainly against the backdrop of a decline in sales

of imported automobiles. Nondurable goods had

been more or less flat, but food and beverages

have decreased recently, reflecting a rise in fresh

food prices stemming from irregular weather.

Meanwhile, services consumption has maintained

its moderate increasing trend, albeit with

23 Regarding the recent decline in the labor share, see Box 3 for a

Japan-U.S. comparison.

24 The Bank revised the compilation methodology of the CAI

recently. For details, see the Bank's research paper "Revision of

the Consumption Activity Index to Address the 2008 SNA and

Improve Accuracy" published in April 2018.

48

49

50

51

52

53

54

94 96 98 00 02 04 06 08 10 12 14 16

Labor share

Average of labor share from 1994

Chart 29: Labor Shares.a., %

CYSource: Cabinet Office.

Notes: 1. Labor share = compensation of employees / nominal GDP ×100

2. Shaded areas indicate recession periods.

96

98

100

102

104

106

108

110

112

08 09 10 11 12 13 14 15 16 17 18

Consumption Activity Index(travel balance adjusted, real)

Consumption of householdsexcluding imputedrent (SNA, real)

Wages and salaries(SNA, real)

Chart 30: Private Consumptions.a., CY 2011=100

Sources: Bank of Japan; Cabinet Office, etc.Notes: 1. The Consumption Activity Index is based on staff calculations (as of April 20).

Figures for the Consumption Activity Index (travel balance adjusted) exclude inbound tourism consumption and include outbound tourism consumption.The figure for 2018/Q1 is the January-February average.

2. The figure for consumption of households excluding imputed rent for 2018/Q1 is based on staff calculations using the "Synthetic Consumption Index (February)."

3. Figures for wages and salaries from 2017/Q2 are based on staff calculations

using employee income (= total cash earnings × number of employees).

CY

28

fluctuations, reflecting a trend rise in

communications charges as well as medical,

health care, and welfare fees.

According to various sales statistics, retail sales

value in real terms has remained on an increasing

trend when fluctuations are smoothed out (Chart

31). Sales at department stores have picked up

as a trend, mainly reflecting a pick-up in sales to

the wealthy brought about by the past rise in stock

prices and an increase in demand from foreign

visitors to Japan. Sales at supermarkets have

been on a moderate increasing trend, albeit with

fluctuations mainly resulting from a rise in fresh

food prices and weather conditions. Those at

convenience stores have continued on a rising

trend.

As for durable goods, sales of automobiles have

started to pick up, after decreasing due to

temporary supply-side problems of automakers

(Chart 32). Sales of household electrical

appliances have been on a moderate increasing

trend due to resilient demand for white goods and

replacement demand for such items as

televisions.

With regard to services consumption, the pick-up

in travel had temporarily paused, partly due to the

effects of geopolitical risks, but has resumed

recently; dining-out has increased (Chart 33).

Looking at confidence indicators related to private

consumption, the Consumer Confidence Index

has been more or less flat due to the favorable

80

85

90

95

100

105

110

115

120

125

10 11 12 13 14 15 16 17 18

Outlays for travel

Sales in the food services industry

Chart 33: Consumption of Servicess.a., CY 2011=100

Sources: Japan Tourism Agency; Japan Food Service Association, "Market Trend Survey of the Food Services Industry."

Note: Figures for the outlays for travel exclude those by foreign travelers.

CY

Chart 31: Consumption Indicators(Sales and Supply-side Statistics)

Sources: Bank of Japan; Ministry of Economy, Trade and Industry; Ministry of Internal

Affairs and Communications.Notes: 1. The Consumption Activity Index is based on staff calculations (as of April 20).

2. Real sales at retail stores are based on staff calculations using the CPI.3. Figures for sales at department stores and sales at supermarkets are adjusted for

the number of stores.4. Figures for the Consumption Activity Index for 2018/Q1 are January-February

averages.

（季節調整済、前期比、％） s.a., q/q % chg.

17/Q2 17/Q3 17/Q4 18/Q1

Real, travel balance adjusted 0.6 -0.2 0.2 -0.1

Real 0.7 -0.1 0.4 -0.2

Nominal 0.6 0.1 1.3 -0.6

Real 0.8 0.0 0.3 -1.8

0.3 0.4 -0.2 -0.2

0.3 -0.1 0.1 0.0

0.4 0.1 0.4 1.0

Consumption Activity Index

Sales at retail stores

Sales at department stores

Sales at supermarkets

Sales at convenience stores

50

60

70

80

90

100

110

120

130

140

150

2

3

4

5

6

10 11 12 13 14 15 16 17 18

New passenger car registrations(including small cars with enginesizes of 660cc or less, left scale)

Sales of household electricalappliances (real, right scale)

Chart 32: Consumption of Durable Goodss.a., ann., mil. units s.a., CY 2011=100

Sources: Japan Automobile Dealers Association; Japan Light Motor Vehicle and Motorcycle Association; Ministry of Economy, Trade and Industry; Ministry of Internal Affairs and Communications.

Note: Figures for real sales of household electrical appliances are based on staff calculations using the retail sales index of machinery and equipment in the "Current Survey of Commerce" and the price index of related items in the CPI.

CY

29

employment situation, albeit with fluctuations that

mainly resulted from a decline in stock prices and

a surge in fresh food prices (Chart 34). The

Economy Watchers Survey suggests that

consumer confidence had continued to improve,

but it has fallen recently, partly reflecting weather

conditions and the decline in stock prices.

In the outlook, private consumption is expected to

follow a moderate increasing trend, supported by

an increase in employee income and by the

wealth effects stemming from the rise in stock

prices, as well as replacement demand for

durable goods, although it is likely to temporarily

turn to a decline in the second half of the

projection period due to the scheduled

consumption tax hike. Meanwhile, the propensity

to consume -- which had declined somewhat

considerably after the consumption tax hike in

2014 -- is expected to pick up very moderately,

mainly reflecting the wealth effects and

replacement demand for durable goods, although

it is likely to level off temporarily after the

scheduled consumption tax hike in 2019 (Chart

35).

Housing investment has been weakening

somewhat (Chart 36). Although an improvement

in the employment and income situation and low

housing loan rates are likely to underpin housing

investment, it is expected to remain more or less

flat when fluctuations due to the scheduled

consumption tax hike are smoothed out, partly

against the background of a peaking-out in

demand for housing for rent that was motivated

by inheritance tax savings.

15

20

25

30

35

40

45

50

55

60

03 05 07 09 11 13 15 17

Consumer Confidence Index

Economy Watchers Survey (household activity)

Chart 34: Confidence Indicators Related to Private Consumption

s.a.

Source: Cabinet Office.Note: Figures for the "Economy Watchers Survey" are those for the current economic

conditions DI.

CY

Improved

Worsened

76

78

80

82

84

86

88

90

102

104

106

108

110

112

114

116

03 05 07 09 11 13 15 17

Consumption Activity Indexdivided by wages and salaries (leftscale)

Private consumption divided bywages and salaries (SNA, leftscale)

Private consumption divided bydisposable income, etc. (SNA,right scale)

Chart 35: Average Propensity to Consumes.a., % s.a., %

Sources: Bank of Japan; Cabinet Office, etc.Notes: 1. The Consumption Activity Index is based on staff calculations.

2. Figures for wages and salaries from 2017/Q2 are based on staff calculations

using employee income (= total cash earnings × number of employees).

3. Private consumption is consumption of households excluding imputed rent.4. "Disposable income, etc." consists of disposable income and "adjustment for the

change in pension entitlements."

CY

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

10

12

14

16

18

20

22

24

03 05 07 09 11 13 15 17

Private residential investment(SNA, real, left scale)

Housing starts(right scale)

Chart 36: Housing Investments.a., ann., tril. yen

CYSources: Cabinet Office; Ministry of Land, Infrastructure, Transport and Tourism.Note: The figure for 2018/Q1 is the January-February average.

s.a., ann., mil. units

30

II. The Current Situation of Prices and

Their Outlook

Developments in Prices

The rate of increase in the producer price index

(PPI, adjusted for the effects of seasonal changes

in electricity rates) has been decelerating on a

quarter-on-quarter basis, reflecting developments

in international commodity prices and foreign

exchange rates (Chart 37). The year-on-year rate

of increase in the services producer price index

(SPPI, excluding international transportation) has

been at around 0.5 percent on the whole, with the

rate of change in prices of items related to

domestic transportation and fixed investment

remaining positive (Chart 37).

The year-on-year rate of change in the CPI (all

items less fresh food and energy) has been at

around 0.5 percent (Chart 38). While the fact that

the pace of increase in the CPI has been

moderate compared to the economic expansion

and the labor market tightening is partly

attributable to the sectoral shock of such factors

as price declines at major supermarket chains

mainly resulting from intensifying competition with

other types of retail businesses, this reflects the

fact that the mindset and behavior based on the

assumption that wages and prices will not

increase easily have been deeply entrenched

among firms and households. Firms have been

making efforts to absorb a rise in labor costs by

increasing labor-saving investment and

streamlining their business process, while limiting

wage increases -- which correspond to the labor

shortage -- mainly to part-time employees. As a

result, the real wage gap, which is defined as the

deviation of real wages from labor productivity,

Chart 37: Inflation Indicators

Sources: Ministry of Internal Affairs and Communications; Bank of Japan; Cabinet Office.Notes: 1. Figures for the Producer Price Index are adjusted to exclude the hike in electric

power charges during the summer season. 2. Figures for the Services Producer Price Index exclude international

transportation.

y/y % chg.

17/Q2 17/Q3 17/Q4 18/Q1

Less fresh food 0.4 0.6 0.9 0.9

Less fresh food and energy 0.0 0.1 0.3 0.5

0.5 0.2 1.1 0.6

0.6 0.6 0.7 0.6

-0.3 0.2 0.1

Domestic demand deflator 0.4 0.5 0.6

Services Producer Price Index

GDP deflator

Consumer Price Index (CPI)

Producer Price Index (q/q % chg.)

-1.0

-0.5

0.0

0.5

1.0

1.5

1 3 1 4 1 5 1 6 1 7 1 8

Goods

General services (less house rent)

House rent (private and imputed rent)

Administered prices

CPI (less fresh food and energy)

Chart 38: CPI (less fresh food and energy)y/y % chg.

Source: Ministry of Internal Affairs and Communications.Notes: 1. Administered prices (less energy) consist of "public services" and "water

charges."2. The CPI figures are adjusted for changes in the consumption tax rate.

CY

-10

0

10

20

82

89

96

103

110

117

124

85 90 95 00 05 10 15

Real wage gap (right scale)

Real wages (left scale)

Labor productivity (left scale)

Sources: Ministry of Finance; Cabinet Office. Notes: 1. The real wage gap is defined as the deviation of real wages from labor

productivity.2. Real wages = personnel expenses / number of workers / GDP deflator3. Labor productivity = (operating profits + personnel expenses + depreciation

expenses) / number of workers / GDP deflator4. Variables such as personnel expenses are based on the "Financial Statements

Statistics of Corporations by Industry, Quarterly" and exclude "finance and insurance."

Chart 39: Real Wage Gap

CY

s.a., 1980/Q1-2017/Q4 avg.=100 %

31

has remained at a low level, and this is

contributing to pushing down prices (Chart 39).25

However, the upward pressure on prices

stemming from the rise in firms' costs has been

increasing, partly due to a continued clear uptrend

in hourly scheduled cash earnings of part-time

employees and a rise in input prices. With regard

to dining-out, for example, some franchises have

passed on rises in personnel expenses and costs

of ingredients to their prices. In reflection of such

developments, the cost-push indicator -- which

quantitatively measures the current upward

pressure on prices stemming from a cost increase

-- shows that such upward pressure has been

increasing, mainly for durable goods (Chart 40).26

The year-on-year rate of change in the CPI (all

items less fresh food) is around 1 percent,

reflecting a rise in energy prices, while the rate of

change in the CPI excluding fresh food and

energy has been at around 0.5 percent (Chart

41).

The recent developments in the indicators for

capturing the underlying trend in the CPI are as

follows (Chart 42). The rate of change in the

trimmed mean has been in the range of 0.5-1.0

25 Regarding the relationship between the real wage gap and

prices, see Box 3 in the July 2017 Outlook Report.

26 For details of the cost-push indicator, see Box 3 in the October

2017 Outlook Report.

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

1 1 1 2 1 3 1 4 1 5 1 6 1 7 18

Other goods Services

Durable goods Clothes

Food products Cost-push indicator

Sources: Ministry of Internal Affairs and Communications, etc.Notes: 1. The cost-push indicator is defined as the weighted average of the residuals

obtained when regressing each CPI item on the corresponding cost indicator, such as the Producer Price Index. The weights are based on the CPI.

2. Figures for 2018/Q1 are January-February averages.

Chart 40: Cost-Push Indicator6-month backward moving avg., %

CY

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

1 3 1 4 1 5 1 6 1 7 1 8

Items other than energy

Energy

CPI (less fresh food)

Chart 41: CPI (less fresh food)y/y % chg.

Source: Ministry of Internal Affairs and Communications.Notes: 1. Energy consists of petroleum products, electricity, and gas, manufactured &

piped.2. The CPI figures are adjusted for changes in the consumption tax rate.

CY

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1 3 1 4 1 5 1 6 1 7 1 8

Trimmed mean

Weighted median

Mode

Chart 42: Various Measures of Core Inflation

y/y % chg.

Sources: Bank of Japan; Ministry of Internal Affairs and Communications.Note: Based on staff calculations using the CPI (consumption tax adjusted).

CY

32

percent.27

The mode and the weighted median

have been in the range of 0.0-0.5 percent of

late.28

Looking at annual price changes across all

items (less fresh food), the share of

price-increasing items minus the share of

price-decreasing items has been on a moderate

uptrend, albeit with fluctuations (Chart 43).

The year-on-year rate of change in the GDP

deflator has been slightly positive on the whole,

despite being negatively affected by the import

deflator that reflects a pick-up in international

commodity prices (Chart 37). The year-on-year

rate of change in the domestic demand deflator

has been at around 0.5 percent, mainly led by

private consumption and business fixed

investment.

27 The effects of large relative price fluctuations are eliminated by

simply excluding items that belong to a certain percentage of the

upper and lower tails of the price fluctuation distribution (10

percent of each tail in this report). The rate of change in the

trimmed mean has been relatively higher than that in the CPI (all

items less fresh food and energy) recently, mainly because

charges for mobile phone services, which had contributed to

pushing down the CPI, were excluded when calculating the

trimmed mean.

28 The mode is the inflation rate with the highest density in the

distribution. The weighted median is the weighted average of the

inflation rates of the items at around the 50 percentile point of the

distribution.

20

30

40

50

60

70

80

90

-60

-40

-20

0

20

40

60

80

1 3 1 4 1 5 1 6 1 7 1 8

Diffusion index (left scale)

Share of increasing items (right scale)

Share of decreasing items (right scale)

Chart 43: Diffusion Index of Price Changes% points %

Sources: Bank of Japan; Ministry of Internal Affairs and Communications.Note: The diffusion index is defined as the share of increasing items minus the share of

decreasing items. The share of increasing/decreasing items is the share of items in the CPI (less fresh food, consumption tax adjusted) whose price indices increased/decreased from a year earlier. Based on staff calculations.

CY

33

The Environment surrounding Prices

In the outlook for prices, the main factors that

determine inflation rates are assessed as follows.

First, the output gap has improved steadily; it was

around 1.5 percent in the October-December

quarter of 2017, and as suggested by

improvement in the Tankan factor utilization index

and in various monthly indexes that indicate the

utilization of labor, it likely will have continued on

an expanding trend within positive territory in the

January-March quarter of 2018 (Charts 4 and

44).29

With regard to the outlook, the output gap

is projected to continue expanding moderately

within positive territory in fiscal 2018, both on the

capital and labor sides, reflecting the increase in

demand at home and abroad. From fiscal 2019

onward, although such expansion is likely to

pause, mainly due to the effects of the scheduled

consumption tax hike, the output gap is expected

to remain substantially positive.

Second, medium- to long-term inflation

expectations have been more or less unchanged

recently, after having remained in a weakening

phase since summer 2015 (Charts 45 and 46). As

for the outlook, such expectations are likely to

follow an increasing trend and gradually converge

to around 2 percent on the back of the following:

(1) in terms of the adaptive component, with the

improvement in the output gap, firms' stance is

likely to gradually shift toward raising wages and

prices and the observed inflation rate is expected

to rise steadily, and (2) in terms of the

forward-looking component, the Bank will pursue

29 In the meantime, the DI in the Tankan for domestic supply and

demand conditions for products and services for large

manufacturing enterprises was at a high level last seen in the

August 1990 survey.

-4

-3

-2

-1

0

1

2

3

4

-8

-6

-4

-2

0

2

4

6

8

85 90 95 00 05 10 15

Output gap (left scale)

CPI (less fresh food and energy,right scale)

Chart 44: Inflation Rate and Output Gapy/y % chg.%

Sources: Ministry of Internal Affairs and Communications; Bank of Japan.Notes: 1. The CPI figures are adjusted for changes in the consumption tax rate.

2. The output gap is based on staff estimations.

CY

0.0

0.5

1.0

1.5

2.0

2.5

05 06 07 08 09 10 11 12 13 14 15 16 17 18

Economist 1 (6 to 10 years ahead)

Economist 2 (7 to 11 years ahead)

Firms (5 years ahead)

Households (Over the next 5 years)

Sources: Bank of Japan; Consensus Economics Inc., "Consensus Forecasts"; JCER, "ESP Forecast."

Notes: 1. Figures for the economist 1 are from the "Consensus Forecasts." Figures for the economist 2 are from the "ESP Forecast."

2. Figures for households are from the "Opinion Survey on the General Public's Views and Behavior," estimated using the modified Carlson-Parkin method.

3. Figures for firms are "Outlook for General Prices (Tankan, all Industries and enterprises, average)."

Chart 45: Inflation Expectations (Survey) y/y, ann. avg., %

CY

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

05 06 07 08 09 10 11 12 13 14 15 16 17 18

Old (10 years)

Old (longest)

New (10 years)

Source: Bloomberg.Note: BEI (break-even inflation) rates are yield spreads between fixed-rate coupon-bearing

JGBs and inflation-indexed JGBs. Inflation-indexed JGBs issued since October 2013are designated as "new," while the rest are designated as "old." Figures for "old(longest)" are calculated using yield data for issue No. 16 of inflation-indexed JGBs,

which matures in June 2018.

Chart 46: Inflation Expectations (BEI)

CY

%

34

monetary easing through its strong commitment

to achieving the price stability target.

The third factor is developments in import prices

(Chart 47). The past rise in crude oil prices

pushed up energy prices in the CPI for the second

half of fiscal 2017, but this effect is likely to wane

moderately.

The Outlook for Prices

With regard to the outlook for prices, the

year-on-year rate of increase in the CPI (all items

less fresh food and energy) is likely to accelerate

on the back of the following developments in the

short run: (1) the rate of increase in prices of

goods that are responsive to economic activity,

including food products and goods related to daily

necessities, is expected to accelerate gradually

with a moderate increase in private consumption,

and (2) moves to pass on the increase in

personnel expenses to prices of general services,

including dining-out and housework-related

services, are likely to prevail, albeit at a very

moderate pace. Thereafter, the year-on-year rate

of change in the CPI is likely to increase toward 2

percent, as firms' stance gradually shifts toward

raising wages and prices with the improvement in

the output gap and as inflation expectations

gradually rise.

The year-on-year rate of change in the CPI (all

items less fresh food) is likely to increase toward

2 percent. This is because, although upward

pressure of energy prices is likely to wane

moderately, the CPI inflation excluding fresh food

and energy is expected to accelerate.

0

30

60

90

120

150

03 05 07 09 11 13 15 17

Crude oil (Dubai) Copper

Chart 47: International Commodity Pricesoil: $/bbl, copper: 100 $/t, monthly avg.

CY

Sources: Nikkei Inc.; Bloomberg.

35

Such projections are made based on the same

underlying scenario as before that the inflation

rate will rise along the Phillips curve with the

improvement in the output gap and that the

Phillips curve will gradually shift upward as

inflation expectations rise through both the

forward-looking and adaptive expectation

formation mechanisms (Chart 48).

Compared to the time when the January 2018

Outlook Report was published, the projected

rates of increase in the CPI (all items less fresh

food) are more or less unchanged.

In the long run, real wages -- which are

determined by the balance between prices and

nominal wages -- will be consistent with labor

productivity (Chart 39). Under the baseline

scenario, the rate of increase in real wages is

expected to accelerate gradually, catching up with

the improvement in labor productivity. That is, with

corporate profits at record high levels, the rate of

increase in nominal wages is projected to outpace

that in the CPI, reflecting tight labor market

conditions. Such a rise in real wages is likely to

increase consumption through an improvement in

household income, which will contribute to a rise

in the CPI.

-3

-2

-1

0

1

2

3

4

-9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8

1983/Q1-2013/Q1

2013/Q2-2018/Q1

A:1983/Q1-2013/Q1

y = 0.36x + 0.7

B:1983/Q1-1995/Q4

y = 0.21x + 1.5

C:1996/Q1-2013/Q1

y = 0.21x + 0.0

Chart 48: Phillips CurveCPI (less fresh food and energy), y/y % chg.

output gap (2-quarter lead, %)

A

B

C

2013/Q2

2018/Q1

Sources: Ministry of Internal Affairs and Communications; Bank of Japan.Notes: 1. The CPI figures are adjusted for changes in the consumption tax rate.

2. The output gap is based on staff estimations.

36

III. Financial Developments in Japan

Financial Conditions

Financial conditions are highly accommodative.

Under "QQE with Yield Curve Control," the yield

curve for Japanese government bonds (JGBs)

has been in line with the current guideline for

market operations, in which the short-term policy

interest rate is set at minus 0.1 percent and the

target level of 10-year JGB yields is around zero

percent (Chart 49). That is, the yields for relatively

short maturities have been stable in slightly

negative territory; the 10-year JGB yields have

generally been stable, at around 0 percent in

positive territory. Meanwhile, the 20-year JGB

yields also have generally been stable, at around

0.5 percent. The monetary base has been

increasing at a high year-on-year growth rate of

around 10 percent, and its amount outstanding as

of end-March was 487 trillion yen, of which the

ratio to nominal GDP was 88 percent.30

With such long- and short-term JGB yields, firms'

funding costs have been hovering at extremely

low levels (Chart 50). Issuance rates for CP have

remained at extremely low levels. Conditions for

CP issuance have been favorable, as suggested

by the DI in the Tankan having been at around the

highest level since 2008, which is when it was

introduced in the Tankan. Issuance rates for

corporate bonds also have remained at extremely

low levels. Meanwhile, lending rates (the average

interest rates on new loans and discounts) have

been around historical low levels.

30 It is assumed that the figure for nominal GDP is unchanged

from the October-December quarter of 2017.

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

0 1 2 3 4 5 6 7 8 9 10 15 20 30 40

January 22, 2018

April 26, 2018

Source: Bloomberg.

Chart 49: Yield Curves

year

%

residual maturity

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

05 06 07 08 09 10 11 12 13 14 15 16 17 18

Bank lending rates (short-term)

Bank lending rates (long-term)

CP (3-month)

Corporate bonds (AA)

Chart 50: Bank Lending Rates and IssuanceYields for CP and Corporate Bonds

Sources: Bank of Japan; Japan Securities Depository Center; Capital Eye; I-N Information Systems; Bloomberg.

Notes: 1. Figures for issuance yields for CP up to September 2009 are the averages for CP (3-month, rated a-1 or higher). Those from October 2009 are the averages for CP (3-month, rated a-1).

2. Figures for issuance yields for corporate bonds are the averages for domestically issued bonds launched on a particular date. Bonds issued by banks and securitiescompanies, etc., are excluded.

3. Figures for bank lending rates and issuance yields for corporate bonds show6-month backward moving averages.

CY

%

-30

-20

-10

0

10

20

30

40

95 97 99 01 03 05 07 09 11 13 15 17

Large enterprises

Small enterprises

Source: Bank of Japan.Note: Based on the Tankan. All industries. There is a discontinuity in the data in December

2003 due to a change in the survey framework.

Chart 51: Lending Attitude of FinancialInstitutions as Perceived by Firms

DI ("accommodative" - "severe"), % points

CY 18

37

With regard to the availability of funds for firms,

the DI in the Tankan for financial institutions'

lending attitudes as perceived by firms suggests

that their lending attitudes have been highly

accommodative; the DI for large firms has been at

a high level of around the peak in the mid-2000s,

and that for small firms has been at a high level

last seen at the end of the 1980s (Chart 51).

Firms' financial positions have been favorable, as

suggested by the DIs for both large and small

firms in the Tankan having been at high levels that

are almost the same as those seen around 1990

(Chart 52).

Demand for funds such as for business fixed

investment has been increasing, mainly for small

and medium-sized firms. In these circumstances,

the year-on-year rate of increase in the amount

outstanding of bank lending has been at around 2

percent (Chart 53). That in the aggregate amount

outstanding of CP and corporate bonds has been

at a relatively high level.

The year-on-year rate of change in the money

stock (M2) has been in the range of 3.0-3.5

percent, as bank lending has increased (Chart

54).

-30

-20

-10

0

10

20

30

40

95 97 99 01 03 05 07 09 11 13 15 17

Large enterprises

Small enterprises

Source: Bank of Japan.Note: Based on the Tankan. All industries. There is a discontinuity in the data in December

2003 due to a change in the survey framework.

Chart 52: Financial Position DI ("easy" - "tight"), % points

CY 18

-6

-4

-2

0

2

4

6

8

10

05 06 07 08 09 10 11 12 13 14 15 16 17 18

Lending by domestic commercial banks

CP and corporate bonds

Chart 53: Amount Outstanding of BankLending, CP, and Corporate Bonds

Sources: Bank of Japan; Japan Securities Depository Center; Japan Securities Dealers Association; I-N Information Systems.

Note: Figures for lending by domestic commercial banks are monthly averages. Figures for CP and corporate bonds are those at the end of period.

CY

y/y % chg.

-1

0

1

2

3

4

5

6

98 00 02 04 06 08 10 12 14 16 18

M2

M3

Source: Bank of Japan.

Chart 54: Money Stock

CY

monthly avg., y/y % chg.

38

Developments in Financial Markets

With regard to developments in global financial

markets, U.S. stock prices -- which had been

marking historical highs -- declined, triggered by a

rise in U.S. long-term interest rates at the

beginning of February, and this led to a fall in

stock prices in many countries through a

heightening of investors' risk aversion. Thereafter,

although stock prices have continued to see large

fluctuations, there have been limited effects so far

on other markets and the real economies.

Yields on 10-year government bonds in the United

States have risen, mainly because wage and

price indicators released at the beginning of

February were stronger than market expectations

and views that the pace of inflation will accelerate

spread among market participants (Chart 55). In

Germany, yields on 10-year government bonds

have been more or less flat with fluctuations

smoothed out, following a rise through February

that mainly reflected solid economic indicators

and the abatement of uncertainties regarding its

political situation.

With regard to credit spreads on interbank

transactions, the LIBOR-OIS spreads for major

currencies show the following developments:

those for the U.S. dollar have widened, mainly

due to the effects of increased issuance of U.S.

Treasury bills; those for the euro and the yen have

remained at low levels (Chart 56). The rise in U.S.

interest rates on term instruments, which includes

the effects of the policy rate hikes by the Federal

Reserve, has led to Japanese financial

institutions' reduced appetite for U.S. dollar

funding through a deterioration in profitability from

-1

0

1

2

3

4

5

10 11 12 13 14 15 16 17 18

Japan

United States

Germany

Source: Bloomberg.

%

CY

Chart 55: 10-Year Government Bond Yields in Selected Advanced Economies

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

10 11 12 13 14 15 16 17 18

Yen

U.S. dollar

Euro

Source: Bloomberg.Note: The credit spreads for term instruments are LIBOR (3-month) minus yields on Ne: overnight index swaps (3-month).

Chart 56: Credit Spreads for Term Instruments

CY

%

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

10 11 12 13 14 15 16 17 18

U.S. dollar/yen

Euro/U.S. dollar

Source: Bloomberg.Note: U.S. dollar funding rate from yen or euro minus 3-month dollar LIBOR.

Chart 57: Dollar Funding Premiums through Foreign Exchange Swaps

CY

%

39

investments in U.S. government bonds. Thus,

premiums for U.S. dollar funding through the

dollar/yen foreign exchange swap market have

declined recently (Chart 57).

Stock prices in the United States and Europe

declined, triggered by a rise in U.S. long-term

interest rates at the beginning of February;

thereafter, they have continued to see large

fluctuations amid uncertainties over the U.S. trade

policy (Chart 58). Japanese stock prices had

been at high levels seen for the first time in about

26 years in the second half of January, but have

fallen since February, due partly to uncertainties

over the U.S. trade policy, with stock prices in the

United States and Europe also declining. In the

Japan real estate investment trust (J-REIT)

market, prices have declined somewhat (Chart

59).

In foreign exchange markets, the yen appreciated

against the U.S. dollar through March as

investors' risk aversion heightened somewhat.

Thereafter, the yen has reverted to depreciation

as the yield differential between Japan and the

United States has widened (Chart 60). The yen

has been more or less flat against the euro, with

fluctuations smoothed out.

60

80

100

120

140

160

180

200

220

240

260

10 11 12 13 14 15 16 17 18

Japan (Nikkei 225 Stock Average)

United States (S&P500)

Europe (EURO STOXX)

Emerging countries (MSCI)

Source: Bloomberg.Note: Figures for emerging countries are based on the MSCI Emerging Markets IndexNo t calculated in the local currencies.

Chart 58: Selected Stock Prices

CY

monthly avg., Jan. 2010=100

60

80

100

120

140

160

180

200

220

240

10 11 12 13 14 15 16 17 18

Japan (TSE REIT Index)

United States (S&P U.S. REIT Index)

Source: Bloomberg.

Chart 59: Selected REIT Indexes

CY

monthly avg., Jan. 2010=100

70

80

90

100

110

120

130

140

150

10 11 12 13 14 15 16 17 18

Yen/U.S. dollar

Yen/euro

Source: Bloomberg.

Chart 60: Yen/U.S. Dollar and Yen/Euro

Yendepreciation

Yenappreciation

yen/U.S. dollar, yen/euro, monthly avg.

CY

40

Land Prices

Land prices as a whole have almost stopped

declining. According to the Land Market Value

Publication for 2018 (as of January 1), the

year-on-year rate of increase in commercial land

prices has accelerated, and the rate of change in

residential land prices has turned positive, albeit

marginally, for the first time in 10 years (Charts 61

and 62). In the three major metropolitan areas

(Tokyo, Osaka, and Nagoya), the year-on-year

rate of increase in both commercial and

residential land prices has accelerated. In

nonmetropolitan areas, the year-on-year rate of

change in commercial land prices has turned

positive for the first time in 26 years, and the rate

of decline in residential land prices has continued

to decelerate.

-25

-20

-15

-10

-5

0

5

10

15

20

25

90 95 00 05 10 15

Nationwide

Three metropolitan areas

Other areas

Tokyo

Chart 61: Residential Land Pricesy/y % chg.

CYSource: Ministry of Land, Infrastructure, Transport and Tourism.Notes: 1. Based on the "Land Market Value Publication." Figures are as of January 1.

2. Three metropolitan areas: the Tokyo area (Tokyo, Kanagawa, Saitama, Chiba, and Ibaraki prefectures), the Osaka area (Osaka, Hyogo, Kyoto, and Naraprefectures), and the Nagoya area (Aichi and Mie prefectures). Other areas: other than the three metropolitan areas.

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

90 95 00 05 10 15

Nationwide

Three metropolitan areas

Other areas

Tokyo

Chart 62: Commercial Land Pricesy/y % chg.

CYSource: Ministry of Land, Infrastructure, Transport and Tourism.Notes: 1. Based on the "Land Market Value Publication." Figures are as of January 1.

2. Three metropolitan areas: the Tokyo area (Tokyo, Kanagawa, Saitama, Chiba, and Ibaraki prefectures), the Osaka area (Osaka, Hyogo, Kyoto, and Naraprefectures), and the Nagoya area (Aichi and Mie prefectures). Other areas: other than the three metropolitan areas.

41

(Box 1) The Net Burden on Households around the Time of Consumption Tax Hikes

In order to consider changes in household

consumption around the time of consumption tax

hikes, it is necessary to take into account not only

changes in the consumption tax rate but also in

the household burden brought about by other

factors.

A look at the increase in the net burden on

households following the two previous

consumption tax hikes shows that, in fiscal 1997,

apart from the hike in the consumption tax rate by

2 percentage points (equivalent to a burden of 5.2

trillion yen), there were substantial additional

increases in the household burden in the form of a

termination of income tax reductions and an

increase in medical costs resulting from reforms

of medical care insurance (Chart B1-1). In fiscal

2014, the tax rate was raised by 3 percentage

points, increasing the household burden by 8.2

trillion yen, and although measures to reduce the

burden were taken, such as increases in welfare

benefits, the effects were lessened by an increase

in pension-related burdens (Chart B1-2). As a

result, the increase in the net burden on

households is estimated to have been about 8

trillion yen around the time of both of the previous

tax hikes.

On the other hand, in fiscal 2019, even though the

consumption tax is scheduled to be raised by 2

percentage points, a number of measures to

mitigate the burden -- such as a reduced tax rate

and an increase in welfare benefits for pensioners

-- and the provision of free education are planned

5.2 -0.1

2.0

1.4 8.5

0

1

2

3

4

5

6

7

8

9

10

Consumptiontax hike

Welfarebenefits

Terminationof income

tax reductions

Reforms ofmedical care

insurance, etc.

Totalincreasein burden

Burden - Benefit

Burden

Benefit

Sources: Cabinet Office; Ministry of Finance. Note: Based on Keizai no Kaiko (Review of the Japanese Economy) 1997 published by the

former Economic Planning Agency.

Chart B1-1: Burden of Consumption TaxHike on Households (FY 1997)

change from FY 1996, tril. yen

Burden increases

8.2 -0.7-0.2 0.3

0.4 8.0

0

1

2

3

4

5

6

7

8

9

10

Consumptiontax hike

Welfarebenefits,

etc.

Taxdeductionsfor housing,

etc.

Increase inpension

contributionrate

Change inpensionbenefits

Totalincreasein burden

Burden - Benefit

Burden

Benefit

Sources: Ministry of Finance; Ministry of Health, Labour and Welfare, etc.Note: "Welfare benefits, etc." includes economic policies to mitigate the impact of the tax

hike on households (Cabinet decision in October 2013).

Chart B1-2: Burden of Consumption Tax Hike on Households (FY 2014)

change from FY 2013, tril. yen

Burden increases

5.6 -1.0

-0.5-1.4

-0.60.2 2.2

0

1

2

3

4

5

6

7

8

9

10

Consump-tion

tax hike

Reducedtax rate

Welfarebenefits,

etc.

Freeeducation

Change inpensionbenefits

Taxreforms

Totalincreasein burden

Burden - Benefit

Burden

Benefit

Sources: Ministry of Finance; Ministry of Health, Labour and Welfare; Consensus Economics Inc., "Consensus Forecast," etc.

Notes: 1. The figure for "change in pension benefits" is based on staff calculations under the following assumptions: (i) the wage growth-slide adjustment rate is equal to the price growth-slide adjustment rate; (ii) the slide adjustment rate under the macroeconomic slide mechanism is -0.6% (including -0.3% carried over from fiscal 2018) in fiscal 2019 and -0.3% in fiscal 2020. Inflation rates are from the "Consensus Forecast."

2. The figure for "free education" is based on staff calculations.

Permanent policies

Chart B1-3: Burden of Consumption Tax Hike on Households (FY 2019)

change in FY 2020 from FY 2018, tril. yen

Burden increases

42

to be implemented (Chart B1-3).31,32,33

As a result,

the net burden on households is expected to be

only about 2 trillion yen. In addition, the fact that

many burden mitigation measures are permanent

is expected to increase their effects.

Thus, in terms of the net burden on households,

the impact of the scheduled consumption tax hike

in fiscal 2019 is expected to be smaller than that

of past tax hikes. Nevertheless, the impact of the

consumption tax hike is highly uncertain, partly

because the effects on consumer sentiment can

differ substantially, depending on economic

conditions at the time of the tax hike.

31 The increase in welfare benefits, etc., shown in Chart B1-3 is

obtained by calculating the net impact, including of welfare

benefits for pensioners and the reduction in nursing care

insurance premiums for low-income households, as well as of the

increased burden through the end of the reduction in employment

insurance premiums, which is a measure limited to three years.

32 The impact of the provision of free education has been

calculated based on information such as from media reports,

making bold assumptions taking into account the government's

financial resources as well as cases of the reductions in the

burden of early childhood education by some municipalities.

33 Unlike in fiscal 1997 and fiscal 2014, when the consumption tax

hike was implemented at the beginning of the fiscal year in April,

the fiscal 2019 tax hike is scheduled for October. For this reason,

in order to make it possible to compare the three tax hikes, the

impact of the October 2019 tax hike in Chart B1-3 is calculated as

the increase in the burden in fiscal 2020 compared to fiscal 2018.

43

(Box 2) The Impact of Exchange Rates on Real Exports

With regard to the link between real exports and

exchange rates, Japan's real exports -- after

having followed an uptrend amid the depreciation

of the yen from 2005 through 2007 -- fell sharply

when the yen rapidly appreciated immediately

after the global financial crisis in 2008 (Chart

B2-1). Since then, however, the link between

exports and exchange rates appears to have

weakened.

To examine this issue quantitatively, we estimated

a time-varying parameter vector auto-regression

(VAR) model consisting of three variables: the

growth rate of overseas economies, the real

effective exchange rate, and real exports (all in

terms of a quarter-on-quarter change) (Chart

B2-2). The estimation results indicate that, while

the sensitivity of exports to exchange rate shocks

increased through the mid-2000s, it fell sharply

after the global financial crisis, and in recent years,

exports have been less affected by exchange

rates (Chart B2-3).

One of the reasons why the exchange rate

sensitivity of exports has declined is that the

price-setting behavior of Japanese firms has

changed. For instance, looking at trends among

automakers, before the global financial crisis,

they undertook a pricing strategy to fix export

prices in yen (i.e., producer currency pricing), and

lowered export prices in the contract currency to

increase market share when the yen depreciated

(Chart B2-4). On the other hand, in recent years,

automakers increasingly have tended to fix export

90

100

110

120

130

140

15040

50

60

70

80

90

100

110

120

00 02 04 06 08 10 12 14 16 18

Real exports (left scale)

Nominal effective exchange rate (right scale)

Sources: Bank of Japan; Ministry of Finance; BIS.Note: Real exports are based on staff calculations.

Chart B2-1: Real Exports and ExchangeRate

Yendepreciation

s.a., CY 2015=100 reversed, CY 2015=100

CY

Chart B2-2: VAR Model Specifications

Estimation Model: 3-Variable Time-VaryingParameter VAR

1. Growth rate of overseas economies, s.a.,q/q % chg.

2. Real effective exchange rate, q/q % chg.

3. Real exports, s.a., q/q % chg., or real exportsof motor vehicles and related goods, s.a.,q/q % chg.

Shock identification is based on Choleskydecomposition in the above order.

Lag: 1 quarter

Estimation period: 1988/Q2-2017/Q4

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

00 02 04 06 08 10 12 14 16

Real exports of motor vehiclesand related goods

Real exports

Sources: IMF; BIS; Bank of Japan; Ministry of Finance, etc.Note: Figures are 4-quarter cumulative changes in response to a 10% Japanese yen

depreciation shock.

Chart B2-3: Exchange Rate Sensitivityof Exports

deviation from baseline, % points

CY

More sensitive to exchange rate

44

prices in the contract currency (i.e., local currency

pricing), leading to a decline in the link with

exchange rates. A reason for such changes is that

exports of Japanese firms have shifted to higher

value-added goods, and thus they are less likely

to get involved in price competition to secure

market share (Chart B2-5).

Meanwhile, an appreciation of the yen exerts

downward pressure on corporate profits when

sales denominated in foreign currencies and

dividend payments from abroad are converted

into yen. In fact, the primary income balance,

which reflects such movements in profits, is

closely linked to exchange rates (Chart B2-6).

However, compared to fluctuations in profits due

to changes in export quantities, those due to

changes in the terms of trade are considered to

have less effect on business fixed investment.34

34 For details, see "Corporate Profits and Business Fixed

Investment: Why are Firms So Cautious about Investment?," Bank

of Japan Review Series (2016-E-2).

70

80

90

100

110

120

130

140

150

85

87

89

91

93

95

97

99

101

103

105

00 02 04 06 08 10 12 14 16 18

Export price index (contract currency basis, left scale)

Nominal effective exchange rate (right scale)

Sources: Bank of Japan; BIS.

Chart B2-4: Export Prices of Motor Vehicles

Decline in export prices/ Yen depreciation

CY 2015=100 CY 2015=100

CY

-40

-20

0

20

40

60

80

100

120

00 02 04 06 08 10 12 14 16 18

Value-added

Quantity

Real exports of motorvehicles

Sources: Bank of Japan; Ministry of Finance.Note: Real exports of motor vehicles are based on staff calculations.

Chart B2-5: The Rising Value-Added ofMotor Vehicle Exports

s.a., change from 2000/Q1, %

CY

-20

-15

-10

-5

0

5

10

15

20-25

-20

-15

-10

-5

0

5

10

15

20

25

00 02 04 06 08 10 12 14 16 18

Primary income receipts (left scale)

Nominal effective exchange rate(right scale)

Sources: Ministry of Finance and Bank of Japan; BIS.Note: The figure for primary income receipts for 2018/Q1 is the January-February average.

Chart B2-6: Income Balance andExchange Rate

reversed, q/q % chg.s.a., q/q % chg.

Decline in primary income receipts / Yen appreciation

CY

45

(Box 3) The Background to Changes in the Labor Share

The labor share is on a downtrend in many

countries. While there are many hypotheses to

explain the decline, this box follows the approach

of Autor et al. (2017), which presents the

"superstar firm hypothesis," to examine recent

labor share trends in Japan.35

The "superstar firm hypothesis" suggests that the

decline in the labor share at the macro-level is

due to the increased market share of some top

firms with a relatively low labor share, referred to

as "superstar firms." To examine changes in the

labor share, these are decomposed into three

components: (1) the "within-firm effect," reflecting

changes in the labor share within individual firms;

(2) the "between-firm effect," reflecting changes in

the market share of incumbent firms; and (3)

"other," which includes firm entry and exit effects

(Chart B3-1).

The results presented by Autor et al. for the

United States indicate that the "between-firm

effect" is the main cause for the decline in the

labor share (Chart B3-2). This suggests that the

labor share at the macro-level decreases as the

market share of "superstar firms" with a low labor

share increases, such as Apple and Amazon.

On the other hand, different results were obtained

for Japan, although it should be noted that this

35 Autor, D., D. Dorn, L. Katz, C. Patterson, and J. Van Reenen

(2017), "The Fall of the Labor Share and the Rise of Superstar

Firms," MIT Working Paper.

Chart B3-1: Decomposition of Labor Share

The change in labor share ΔS from time t to t +kis decomposed as follows:

ΔS ＝

(a) and (b) are calculated based on incumbent firms at time t and t +k.

S denotes the labor share. w is the share of value-added, where value-added is defined as the sum of operating profits and personnel expenses.

and denote the unweighted mean of the labor share and value-added, respectively.

The data are unbalanced, cover about 550,000 firms, and span the period from FY 2000 to 2016.Other is calculated as the residual.

(a) Within-firm effect

(b) Between-firm effect

-15

-10

-5

0

5

10

Retail Manu-facturing

Services Whole-sale

Utils+Transport

Within-firm effect

Between-firm effect

Other

Total

白線用

Chart B3-2: Decomposition of the Changein the Labor Share in the U.S.

change from CY 1982 to 2012, % points

Source: Autor, D., D. Dorn, L. Katz, C. Patterson, and J. Van Reenen (2017), "The Fall of theLabor Share and the Rise of Superstar Firms," MIT Working Paper.

Notes: 1. "Other" consists of firm entry and exit effects, etc.2. The decomposition for "Utils + Transport" is for the period from CY 1992 to 2007.

46

could be partly due to differences such as in the

observation period. Specifically, the results show

that not only the "between-firm effect" but also the

"within-firm effect" have made a substantial

contribution to the decline in the labor share

(Chart B3-3).

Looking at the decomposition of the change in the

labor share for all industries in Japan over time, a

notable feature in recent years is that the

"within-firm effect" has been lowering the labor

share (Chart B3-4). This likely reflects the current

situation in which individual firms have been

raising productivity against the backdrop of labor

shortage while real wage growth has been

relatively restrained (Chart 39).36

36 See Box 3 in the July 2017 Outlook Report.

-20

-15

-10

-5

0

5

10

Retail Manu-facturing

Services Whole-sale

Utils+Transport,

etc.

Construc-tion

Within-firm effect

Between-firm effect

Other

Total

白線用

Chart B3-3: Decomposition of the Changein the Labor Share in Japan

change from FY 2000 to 2016, % points

Source: Teikoku Databank.Notes: 1. Value-added = operating profits + personnel expenses, labor share = personnel

expenses / value-added. Observations with negative value-added and a firm-level labor share at the 95th percentile or above were excluded as outliers.

2. "Other" consists of firm entry and exit effects, etc.

-10

-8

-6

-4

-2

0

2

4

6

01 03 05 07 09 11 13 15

Within-firm effect

Between-firm effect

Other

Total

Chart B3-4: Decomposition of the Changein the Labor Share, FY 2001 to 2016

Source: Teikoku Databank.Notes: 1. Value-added = operating profits + personnel expenses, labor share = personnel

expenses / value-added. Observations with negative value-added and a firm-level labor share at the 95th percentile or above were excluded as outliers.

2. "Other" consists of firm entry and exit effects, etc.

FY

change from FY 2000, % points